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Common missteps when structuring a private offering

Posted on January 16, 2019 at 1:40 AM

Using phrases like “the first” or “the only” can be problematic. Issuers should avoid any statements that can be construed as guarantees. When outlining the investment opportunity, cut to the chase. Less is more. Back up claims with references to reputable sources. Impress with thorough research and summaries of recent information from reputable sources. Use concise language. Avoid revisions that cause delay.

Offerings of operating companies rise and fall on their valuations. A valuation that is too low can lead to future dilution of owner’s equity while lowering the maximum that can be raised. A valuation that is too high can make it difficult to raise any capital at all. Try to have a well-reasoned rationale for the valuation.

Even a well crafted and sharply focused business plan will receive little interest with questionable investor returns or obviously excessive management fees. If management does not participate in profits until after investors' capital is returned, investors will be more willing to assume more risk. Inexplicable differences from industry average returns and fee structures are difficult to explain to investors. Some investors will not even try to figure out what the potential net return is, so make it easy for them. Multiple line items for consulting and advisory fees are red flags.

Use of proceeds that recaps the founders’ investment capital, if the capital was originally characterized as a loan, is understandably problematic. Real estate offerings using more than 70% leverage to acquire property will be perceived as risky, although high leverage can be appropriate in stabilized, low vacancy properties with creditworthy master tenants and a stable lease profile. Equity stack positions are appropriate for offerings of buy-and-hold-and-pray undeveloped land deals.

Commissions offered in Regulation D exempt offerings vary substantially by industry, but placement fees and broker compensation should not be so high as to be contrary to an investors’ interest. Try to use a flexible commission structure using language such as “up to X%” rather than a stated percentage. This will allow you to refer the deal to other brokers with a conventional syndicated commission structure if you need to go that way.

If the minimum offering amount is not received before the offering termination date, you face the time-consuming and irksome chore of notifying subscribers that the offering needs to be extended. And this notification can trigger a right of rescission giving an investor the right to reverse his or her decision to subscribe! Be sure to include a right to extend the offering period at the issuer's discretion. Allowing ample time for the offering avoids the need for “bridge” financing and permits the possibility of alternative financing sources.

A first impression is important when asking people for money. In this case, the first impression will likely be based on your offering documents including private placement memorandum (PPM), pitch deck, executive summary, and other documents. This is especially true for online offerings using a Regulation D, Rule 506(c exemption. Common pitfalls include hyperbolic pro-formas or financial models. Remember to be reasonable about forecasts and be sure to employ sensible operating metrics. Remember to identify the larger market relative to the revenue opportunity.

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Categories: New Capital Options, S.E.C., Regulation D

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